First let’s dive in to the mechanics of what’s changed. We were accustomed to a market where there was practically no volatility. Complacency was high and on a technical basis the Dow and S&P were more overbought than at any period since perhaps 1929. In essence euphoria and perhaps even blind optimism were becoming extreme. That condition quickly and violently reversed as more than five trillion dollars of market capitalization have been wiped out by selling since January 26th, 2018.

Volatility has returned

We’re now seeing volatility pick up and equities give back much of their gains over the past several months rapidly. Downward moves are generally faster paced and more intense than moves upward. Easy come, easier go.

That relatively uneventful journey up in most of 2017 is part of the problem with markets right now. During the rise in prices equities didn’t consolidate or correct which led to almost no technical support for buyers.

This is important because when there is volatility, market participants often utilize charts and technical patterns to determine areas of support. But in moves that are parabolic there generally aren’t such areas of technical support on the chart to rely on. So buyers (both human and bots) are more shy to put a bid out.

Fear is a powerful emotion

When volatility picks up and losses accumulate, speculators that used leverage (debt) to buy equities are often hit the hardest, forced to liquidate their positions. When this sort of activity crescendos with other investors panicking we typically see a capitulation selling event. I’m not certain we’ve seen that event as of yet, though. The market will have to demonstrate whether or not it has buyers here.

An example of how powerful fear can be is how inverse volatility index (VIX) ETFs have imploded in the wake of volatility returning to markets, meaning buyers who bet against intense trading price ranges were essentially wiped out. This trade worked well for years — until one day it didn’t.

These dislocations are not enough to create a full on selling panic on their own. Instead they are representative of instruments that were too heavily bought in to on the long side unraveling as the markets normalize to higher levels of volatility.

Bots are not buyers during sell-offs

High frequency trading bots have overtaken humans as the largest component of buying and selling volume for US equities. That seems efficient in theory, but the problem we see is when the selling intensifies the bots stop bidding. That allows declines to intensify as those wishing to exit will be fighting against a larger spread and less buy-side liquidity.

Indeed, during the last week we’ve seen situations where smaller lots were moving markets up and down by handles, rather than ticks. That’s the sort of activity one expects in an illiquid and immature market. Yet we are seeing it on a continuing basis here in the US with its extremely deep and previously liquid stock markets.

Technically speaking

Zooming out to a 30,000ft perspective, we haven’t seen any truly significant selling. Even though many points have been lost on major indices, this selling event is relatively normal. The pace of it is a bit intense, but for a maturing bull market one should expect increasing volatility along with leadership consolidation.

The S&P 500 appears to be hitting a lower area of support. Watching to see whether cautious buyers come in for a move more substantive than a “dead cat bounce” is crucial in determining whether or not the downward move is ending or if there is more to go. If we move meaningfully down from here across the US equity indices I believe we are going to see much more significant selling pressure and volatility.

It’s almost entirely about rates

The selling intensity and loss of confidence in bidding up equities seems to be tied to increasing rates on the longer end of the yield curve. Related to that development is that inflation expectations are beginning to change and concerns are rising. That is to say, bond buyers may be questioning whether a 10 year bond at 2.851% is a fair interest rate or if perhaps a higher rate is justified based on what the rate of inflation may be over the next 10 year period. If buyers commit to an interest rate that is lower than inflation they walk away with a loss when the coupon matures.

While the yield curve has had a flattening spread for several years — it is beginning to steepen again. Higher interest rates are also inducing higher borrowing costs for mortgages, margin debt as well as other variable rate debts and could compress consumer spending as well as market buy-side participation. Borrowing costs are one of the most important factors in market psychology as well as interest earned on presumably safe government bonds.

That means if the 10 year bond continues higher, say at 3% or more, then many equity participants may re-balance their portfolio away from equities and more towards US Treasury bonds. Assuming other shorter dated bonds were not as well bought, that change would steepen the yield curve which would also potentially assist lenders in capturing a larger interest rate delta between the short term borrowing they engage in vs. the long term lending at higher rates.

On the other side of that, if yields peak and meaningfully decline then there is a fair chance that a bid returns to the equity markets and they move meaningfully higher. Whether or not stocks are able to make a higher high in prices is the most important technical consideration for maintaining a healthy bull market uptrend.

Economic development trajectory

If economic data begins to slow meaningfully, which it may with higher rates, that is another area where weakness may be demonstrated as a result of reduced economic participant confidence. Such slowdowns often happen as rates increase and borrowing costs rise at the end of a business cycle. The most leveraged companies, states, cities and private debt holders are hit the hardest.

Closing thoughts

As I told a friend, the “crisis” now is that there is a lack of a crisis to keep crisis-level accommodations flowing. In essence the central bank liquidity spigots are slowing and commercial lending is taking a breather. The Fed has also recently made it clear that the “Powell Put” is at much lower price levels.

These developments impact both equity markets and real-world economic activity. I’ll be watching the economic data releases, interest rate complex, especially 10 year yields and junk bonds, to see where equities may go from here.

Maybe so. Maybe not. However, I’m content to watch from the sidelines. Last year these cryptos saw levels of appreciation that were nothing short of parabolic.

I wouldn’t be surprised to see them fall more, but if they bounce and go up meaningfully from here I think that may actually be the most dangerous sign for their long term pricing. That is to say, if the bubble psychology continues then when reality does finally catch up, and it will, I believe it will be a harder landing.

Bitcoin bubble?

My reason for looking at these cryptos with skepticism is that:

1: There are 1,442 cryptocurrencies and not a single one has a viable use case in real-life commerce.

2: The second most popular coin, Ethereum, has no limit to how many can be created. How can that be a store of value?

3: Bitcoin consumes an inordinate amount of power. At this price it takes about 10 days worth of power for an average American home to reconcile each transaction. That is unsustainable and the problem gets worse at higher prices.

4: There is almost no liquidity in day to day trading. That is to say when price action gets wild, especially to the downside, the bid just vanishes. That means it’s impossible to get out of the way of a crash. And some exchanges become so overwhelmed they just stop accepting orders. But the worst part is because the miners are in charge of the entire construct, there are times when their memory pool gets clogged up with orders, fees skyrocket and each transaction can take weeks+ to clear.

5: From a technical analysis perspective, everything looks toppy. There’s a lot of downside risk and the upside potential is difficult to quantify.

6: There is zero validity to any of the price action, especially since it is driven by very small amounts of capital. It’s essentially the greater fool theory with very little liquidity. As an example, Bitcoin has leaped thousands of dollars with single trades being made in the liquidity vacuum of their shark-driven exchanges.

7: Retail investors have been taking out loans, including second mortgages and credit card debt, to speculate in this space. This sort of activity generally marks a speculative top. Since then most cryptos have been tumbling as fresh capital is not entering the space.

That all being said, of all the cryptocurrencies, Ripple may be one that has some potential as it is already seeing some use in commerce and interbank funding. Then, maybe Ethereum, but there’s the problem with Proof of Stake and whether the implementation will go well combined with unlimited potential coin creation. IOTA seems interesting, but it’s still very experimental.

In closing, I am still content to watch this space and see how this situation plays out. I don’t believe that cryptocurrencies are the solution to our financial system woes. The level of corruption and fraud that have occurred at the exchanges and in the ICO space is staggering and makes some of the Wall Street bucket shops of the 80s look almost angelic in comparison — and I say that as a skeptic of Wall Street’s integrity and honesty.

I remain reluctantly bullish on gold, silver and platinum (and bearish of palladium). I fear we are entering a time of turbulence via geopolitical events, monetary policy tightening (during the greatest policy experiment perhaps in human history); a national, state and city debtastrophe, retail implosion (in a sector that employs millions) and an increasingly gig-oriented job market — that provides quite poorly for its paycheck-to-paycheck participants. The housing bubble 2.0 is beginning to sputter with almost as much leverage as 2007 in the speculative areas (flippers especially).

Further, I fear that the economic recovery did not manifest as hoped, and instead we’re seeing fudged metrics across the board (whether it is labor statistics that are double and triple counting the aforementioned gig jobs as separate people each getting a new job — when it is a single person with 2-3 jobs). We see funny data coming from Facebook where they are saying they have more users than the US census says we have population. We see enormous misallocations of capital as a result of these and other fuzzy numbers. At the end of the day we have a weak economy that is limping along, despite the record setting stock market saying otherwise as its returns grace the headlines on a near daily basis.

GDP growth has largely been predicated upon expansions in cost, not true increases in activity. Medical costs being one of the primary drivers, which are now rising at about 200% the rate of inflation by conservative measures. Compounding that problem is the fact that the FIRE (finance, insurance, real estate) component of the economy continues to occupy an outsized portion of GDP, creating a situation that has changed the lubricant for the engine of economic growth in to a drag.

So much wealth has been transferred vis-a-vis QE and this ongoing monetary policy experiment, from the working and middle glass to the very wealthy. This further creates an enormous strain on the largest input of US economic growth — consumption. Combining that with the overhang of student debt which is now approaching or exceeding $1T depending on the measure. We have a growing swath of consumers that can’t afford to engage in their namesake activity. And we just broke through record credit card debt in the US. So it’s safe to say we’ve pushed a lot of consumption forward without the means to keep that pace going.

Shifting gears to the central bank conundrum, a Warsh appointment at the Fed doesn’t do much to resolve the largest quandary in the institution’s history: how to unwind a 4.5 trillion dollar balance sheet before the next crisis — without causing the next crisis? Warsh’s own WSJ op-ed opined about his remorse and skepticism regarding QE. Will he be capable of unwinding what he admits he (and others at the Fed) barely even understand? It will be fascinating to watch. Makes buying VIX long dated calls look tempting if he is appointed and such an endeavor is undertaken. The current unwinding of the balance sheet is unrealistically slow unless they never intend to normalize.

What are the odds that this equity bull market, the second longest in US history by my calculation, continues unabated? I would imagine further strength in equities is required to keep the Fed determined to raise interest rates — and significant weakness could pause the tightening or even reverse it. Even if Warsh is at the helm, he would be under massive pressure from the administration to keep the economy looking better the closer we get to re-election.

That all said, I think we are navigating one of the most fascinating markets in my lifetime. It has evaded almost all logic and reason. So many much more gifted investors than me have missed a lot of this rally having been extremely skeptical of its durability and potential.

At this time I don’t see a lot of value in the US markets. Valuations feel stretched and equities priced to perfection. I’ve been allocating more capital in to emerging markets where the yields are higher, the valuations are more fair and there is some potential for hedging against US dollar weakness — which still concerns me over the intermediate to long run.

I plan to increase my own exposure to high quality silver miners based on my thesis that silver industrial usage will increase with larger demand for solar power, communications, computers, mobile devices and weapons systems (such as drones and missiles). Unlike gold, silver is used and quite hard to reclaim. Silver investing may also grow in time, but that isn’t the center of my thesis with silver. I suspect, instead, that investment will remain flat and the outsized portion of increased utilization will be non-reusable applications. That, and the fact that silver is generally mined as a secondary metal (incidentally rather than purposefully) at most mines, makes the opportunity a bit more bullish for me than gold.

It’s a very difficult metal to analyze, though. Thinly traded, often beaten up by large banks in concert (silver price rigging investigations have proven that several of the largest banks in the EU and US were working together covertly to suppress prices — and they saw minimal consequences for this activity).

Trading silver is not for the faint of heart, either. I spent a few months trading small lots of silver mini contracts and found the volatility very difficult to execute against because the bid would just dry up during times of high selling pressure. Most of the silver miners are much more liquid than the futures, which is a bonus. But there are very few of them to choose from and even fewer worth investing in.

As always I hope my commentaries are constructive to those who make their way through them!

Full disclose: Long positions in emerging markets bonds, stocks, precious metals mining companies; short position against NASDAQ 100.

There’s so much talk of Amazon bringing doom to all things retail that I think it’s fair to take a step back and look at the bigger picture. A massive downsizing of US retail was inevitable. We have 600%+ more retail space in shops, malls and megastores than any other first world country. That’s a big tell.

Adding to that, as Americans we tend to overspend, beyond our means, and use debt to drive that consumption forward. That is to say, we can’t collectively always afford what we’re buying, so we tend borrow to buy. That cycle of debt-driven overconsumption did not end well in 2007-2008. Since then we’ve seen mid-tier and low-tier discretionary spending trends at many retail stores flat to down as consumers try to deleverage.

It’s also becoming more obvious that online shopping is driving sales away from brick and mortar companies who haven’t had the wherewithal to create a cohesive online shopping experience — or who have failed to effectively solidify customer loyalty. Further, as companies like Amazon grow and offer a sort of “Walmart of the Internet” approach to allow someone to do most of their shopping on a single website, ill prepared stores will suffer, losing more sales and customers.

But I feel that there are much bigger catalysts at work here as well. We’re confronting a generational shift from tangible consumerism to intangible consumerism. Retail stores have trouble selling intangibles. An example of that would be GameStop, who should be flourishing in the age of electronic sports and online gaming, but is instead collapsing in on itself due to its inability to execute online. Meanwhile, companies like Activision Blizzard, Valve, EA Games and others have created extremely lucrative online game distribution platforms, tying together the purchasing, social and gaming experience.

The same is true of application spending. Surely no customer is going to trek out to a store to download an application on to their phone, tablet or computer. That used to be the case, however, as software was too bulky to download and vendors were cautious to distribute online for fear of piracy. But much has changed since the early days of software distribution.

How we buy, what we buy and whom we buy it from are all changing. This appears to be a generational shift perhaps almost as much as it is a correction in retail overabundance to more normalized levels.

Uh oh! Is the new housing bubble beginning to deflate? My thought is yes, but let’s not move to hastily to that conclusion before walking through some facts:

1: Many lenders were / are offering mortgage down payments from 1-3% (sometimes as low as 0%). This means that even if a buyer is not able to save money such that they can make a reasonable down payment (or have money set aside if they lose their job, have to make a major repair, etc) they can still be granted a mortgage to buy a property that they make default on.

2: Home values have reached levels near or beyond the highs of 2007 (depending on which region one examines). This means that for most working people buying a home is not something that they can reasonably afford. And if they can they do so under extreme financial stress, making debtors who acquire a mortgage on a property more prone to defaulting.

3: The millennial student debt bubble has grown to over $1.4T. These poor souls who were overcharged for an education that may not lead to better income prospects have little chance of obtaining a mortgage for a home if they are hamstrung by so much debt, poor job prospects and potentially low credit scores. In addition, many millennials have opted to downsize and live in smaller spaces (micro apartments, studios, pods in the parents’ backyard, etc).

4: Many people whom are intending to buy a new house must also sell their existing property. It is more and more difficult to do so with prices on the rise. Somewhere either demand must rise to the higher prices or the supply must fall to more reasonable prices. I suspect the latter will happen given the current macroeconomic environment (final stages of current business cycle).

5: A lot of quasi-affordable housing stock is being leveled and replaced with gaudy, poor quality McMansions by rabid speculators. These housing units tend to have shorter lifespans before major repairs are necessary since builders prioritize quantity over quality. As a result, housing stock that is the most desirable to middle class buyers is being eviscerated while unaffordable, low quality and undesirable housing stock is growing. This is a large, and mostly unrealized problem as of yet.

Without near zero interest rates, and the Fed holding an enormous amount of defunct MBS (mortgage backed security) notes there would be no housing bubble right now. But because we are in an artificially low interest rate environment with massive stimulus in the mortgage market, there is likely a large bubble in real estate valuations that is extremely perilous.

First we were told Mexico would pay for it before the project started. Then we were told they would pay for it later after it was built. Now we’re told that our government will be shut down if we, the American tax payers, don’t fund this ridiculous and counterproductive project.

I don’t tend to post political content on here often, but since this administration seems dead set on creating intractable political turmoil I believe some attention is warranted.

President Trump has, at least in the initial 6 months of his presidency, provided a positive catalyst for US equities. Whereas the underlying theme was deregulation, tax cuts, corporate favoritism (as if we needed much more of that) and a promise of infrastructure spending.

Thus far just about none of that has materialized in any meaningful way. In fact, I think it’s fair to say that the US equity, bond and global forex markets are beginning to realize this as volatility ratchets up.

I fear that President Trump has set the stage for a steep decline in equities due to the market disappointment of having his policies unrealized combined with the realization that in all likelihood he is unable to effectively execute his duties as President.

Advertising isn’t what it used to be as spending is continuing to plunge. Earnings of large digital advertising companies, such as Google, Facebook, Microsoft and Verizon are under threat (with the former two being the most concentrated risks due to their large exposure).

When major consumer staples pull back on hundreds of millions of dollars in ad spending I think it’s take to take notice. These trend setting marketing departments may just be the first dominoes to fall in the realization that advertising spending for well known brands may not actually lead to increased sales.

Further, there remains the question as to whether digital marketing is producing value for money spent. Personally I feel that in the last few years we’ve entered a period of hyperoptimism about the future of digital advertising. There are enormous problems that break the existing revenue model if they are to be realized by customers. Yet there is very little effort by large digital advertising companies to curb them because doing so would significantly impact earnings and growth. So it appears as though customers are departing en masse instead.

Equities in the US are expensive, so it wouldn’t be unheard of to see some selling build in to the recent down days. The record setting highs of late were set on ever decreasing buying volume, record margin debt and with stocks that were already priced to perfection. If I had to guess, the path of least resistance for the short term is lower.

It’s healthy in any bull market to see a correction. This particular bull market hasn’t had too many, which has been somewhat unusual. However, the buy the dip mentality is firmly baked in. So I would not be surprised to see a big dip aggressively bought. Whether that creates a higher high or a lower high (in technical terms) remains to be seen — and will be interesting to determine the trend from here.

At 10:31 am EST the NASDAQ is sinking lower, despite Apple’s massive rally following positive earnings. Other techs are notably soft and weakening. This, to me, is a very disconcerting sign for those who may be long growth technology stocks.

Meanwhile, the VIX started below $10 today, which seems to be relatively accurate gauge of market participant complacency. I don’t think enough money managers are hedging risk as the market continues to make all time highs.

I seem to remember a similar feeling of market euphoria where nothing could possibly go wrong back in 2007. I’m not saying that this is a market top, but there’s really no way to tell until later.

Full disclosure: Short NASDAQ 100. May increase short over next 48 hours.

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